What are leading, lagging and coincident indicators? What are they for?

An indicator is anything that can be used to predict future financial or economic trends. For example, the social and economic statistics published by accredited sources such as U.S. government departments are indicators. Popular indicators include unemployment rates, housing starts, inflationary indexes, and consumer confidence.

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Official indicators must meet certain set criteria; there are three categories of indicators, classified according to the types of predictions they make.

Leading indicators - These types of indicators signal future events. Think of how the amber traffic light indicates the coming of the red light. In the world of finance, leading indicators work the same way but are less accurate than the street light. Bond yields are thought to be a good leading indicator of the stock market because bond traders anticipate and speculate trends in the economy (even though they aren't always right). New housing starts, money supply M2, and stock prices fall under leading indicators.

Lagging indicators - A lagging indicator is one that follows an event. Back to our traffic light example: the amber light is a lagging indicator for the green light because amber trails green. The importance of a lagging indicator is its ability to confirm that a pattern is occurring. Unemployment is one of the most popular lagging indicators. If the unemployment rate is rising, it indicates that the economy has been doing poorly. Another example of a lagging indicator is the Consumer Price Index (CPI) which measures changes in the inflation rate.

Coincident indicators - These indicators occur at approximately the same time as the conditions they signify. In our traffic light example, the green light would be a coincidental indicator of the associated pedestrian walk signal. Rather than predicting future events, these types of indicators change at the same time as the economy or stock market. Personal income is a coincidental indicator for the economy: high personal income rates will coincide with a strong economy. The GDP of an economy is also a coincident indicator.

In summary, leading indicators move ahead of the economic cycle, coincident indicators move with the economy, and lagging indicators trail behind the economic cycle.